Typical Tax issues Typical Tax issues in NBFCs

28 January 20131

Presented by :Hitesh R. ShahChartered Accountant

� It is a company registered under the CompaniesAct , 1956 and is engaged in the business offinancing whether by way of making loans andadvancesadvances

� Acquisition of Shares, Stocks , Bonds,Debentures, Securities issued by a Govt or localauthority or other securities of like marketablenature

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� Leasing, hire purchase, insurance business, chitbusiness but does not include any institutionwhose principal business is that of agriculturalactivity/ industrial activity /sale/purchaseactivity/ industrial activity /sale/purchase/construction of immovable property.

� principal business of accepting deposits orlending .

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� RBI Act 1934 particularly Chapter IIIB, IIIC and V

� The NBFC Acceptance of Public Deposit (ReserveBank ) Directions 1998

� The Non Banking Financial (Deposit accepting orholding) companies Prudential norms (Reserveholding) companies Prudential norms (ReserveBank ) Directions 2007

� The Non Banking Financial (Non-Depositaccepting or holding) companies Prudentialnorms ( Reserve Bank ) Directions 2007

� The NBFC Auditors’ Report (Reserve Bank )Directions ,2008

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NBFC BANK

� NBFC are registered underCompanies Act 1956.

� NBFC can not acceptdemand deposits.

NBFC is not a part of

� Banks are incorporatedunder Banking RegulationAct.

� Banks can accept demanddeposits.

� NBFC is not a part ofpayment and settlementsystem and as such , aNBFC cannot issue chequesdrawn on itself.

� Deposit issuance and CreditGuarantee Corporation(DICGC) is not available forNBFC depositors unlike incase of banks.

deposits.� Banks are part of paymentand settlement system andcan issue cheques drawn onitself.

� Deposit issuance and CreditGuarantee Corporation(DICGC) is available forbank depositors unlike incase of NBFCs.

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� It is mandatory for every NBFC to register u/s 45of RBI Act to carry on business of Non bankingfinancial Institution.

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� Income Tax Act 1961 however does not containspecific provision for NBFC unlike Banking andInsurance companies

� Income of NBFC needs to be computed undereach head of Income mentioned in section 14 ofeach head of Income mentioned in section 14 ofthe Act.

� Expenditure incurred prior to set up :

Expenditure incurred prior to set up of abusiness are not allowable expenditure.

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� Issues:

What should be the date of set up of the business?

� Three situation for deciding date of Setup /Commencement of Business:◦ Date on which in Principle approval is granted by RBI on◦ Date on which in Principle approval is granted by RBI onmaking an application.

◦ Date on which application is made to RBI to issue finalapproval for commencement of business.

◦ Date on which final Approval is granted by RBI.

� CIT v. PIEM Hotels Pvt Ltd 209 ITR 616 (Bom)

� Western India Vegetable Products Ltd V. CIT 26 ITR151 (Bom)

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� Interest earned prior to Setup of Business:Interest Income that applicant might earn on placing ofmoney in fixed deposit ought to be taxed as under thehead ‘ Income from Other Sources’.

�Taxation of Interest income from Investment of�Taxation of Interest income from Investment oftemporary Surplus.NBFC may have short interval between funds generatedto make a particular investments and actually makinginvestments. Funds are placed for a short period in afixed deposits which earn some interest.

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�Whether interest Income can be considered asIncome from other sources or Income frombusiness operations?As funds otherwise used for the business havebeen parked for temporary period and ought notto alter the Character of these funds and maketo alter the Character of these funds and makethem surplus funds. Hence taxable as ‘Profits andGains of Business or Profession’

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� Contrary View in

� ACIT Vs. Lafarge India Holding Pvt Ltd. 19SOT 121 (Mum) (ITAT)◦ It was held that Interest earned had absolutely norelation with the business of the company. Interestrelation with the business of the company. InterestIncome in respect of surplus money not requiredfor business and deposited in bank , as idle moneyfor safe keeping would be assessable as Incomefrom other Sources.

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� Whether provisions for doubtful debts made in accordance withRBI guidelines allowable ?

� NBFCs are required to make certain provisions for NPA as per RBIprudential norms issued by the RBI. Unlike Banks where provisionfor Bad and doubtful debt is specifically deductible under section36(1)(via) of the Income Tax Act. There is no specific provisionwhich allows deduction to NBFC.which allows deduction to NBFC.

� The Supreme Court in Southern Technologies Ltd Vs JCIT (2010)320 ITR 577 held that RBI directions is only the context ofpresentation of NPA provisions in the balance sheet of an NBFCand has nothing to do with the computation of taxable income oraccounting concepts. The Income Tax Act and RBI directionsoperate in different field. The nature of expenditure under theAct can not be conclusively determined by the manner in whichaccounts are presented under RBI directions.

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� Explanations to section 36(1) (vii) of the Actclarifies that any bad debts written off asirrecoverable in the accounts of the assesse willnot include any provisions for doubtful debts.Further as per section 36(2) amount of debtshould have been taken into account incomputing the income of the assesse in previouscomputing the income of the assesse in previousyear. Provisions of NPA in terms of RBI directionsdoes not constitute expense on the basis ofwhich deduction can be claimed by NBFC underIncome Tax Act.

� A provision for NPA is an expenses under RBIdirections and in that sense it is notional.

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� Discrimination:

◦ NBFC are discriminated as against the Banksbecause of the above said judgements.

◦ DTC Bill 2010 seeks to remove the discriminationand place both banks and NBFC at par.

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� Income on NPA or sticky loans be taxed on accrual basisi.e. as and when due date of receipt arises?

� In CIT Vs Vasisth Chay Vypar Ltd (2011) 330 ITR 440 (Del)As per the RBI Act and Directions , mandate an NBFC todeclare advances as NPA when the accrued interesttherein is not paid by the debtor continuously for sixmonths.therein is not paid by the debtor continuously for sixmonths.Assessee had not received any interest income on NPA,income cannot be said to have accrued to the assesseehaving regard to the provisions of s. 45Q of the RBI Actand prudential norms issued by the RBI—Even under the ITAct, interest income had not accrued.Moreover, when there is a provision in other enactmentwhich contains a non obstante clause (45Q Of RBI Act),that would override the provisions of IT Act.

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� Investments held as stock in trade:

◦ Ethio Plastics Pvt. Ltd. V. DCIT (ITAT AHD)

S. 14A does not apply to shares held as stock-in-trade. As the assesse isengaged in the business of dealing in shares and the shares were held asstock-in-trade, the intention of the assessee was not to earn dividendincome. As the dividend received was incidental to the business of sale ofshares, no notional expenditure could be disallowed by invoking s. 14A.

◦ CCI LTD. vs. JOINT COMMISSIONER OF INCOME TAX (2012) 71 DTR (Kar) 141◦ CCI LTD. vs. JOINT COMMISSIONER OF INCOME TAX (2012) 71 DTR (Kar) 141

When the assesse has not retained shares with the intention of earningdividend income and the dividend income is incidental to his business ofsale of shares, which remained unsold by the assesse, it cannot be saidthat the expenditure incurred in acquiring the shares has to be apportionedto the extent of dividend income and that should be disallowed fromdeductions. Provisions of s. 14A were not applicable to the expensesincurred by the assessee in the course of its business of share dealingmerely because the assessee is also having dividend income.

o Esquire Pvt Ltd Vs DCIT ITAT (mum) ITA No 5688/Mum/2011

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� If Investment held as Capital Asset:◦ DCIT vs. Tata Investment Corporation Ltd. [2008] 113

TTJ 512(MUM.)Section 14A of the Income-tax Act, 1961 - Expenditureincurred in relation to income not includible in totalincome.

Assessee was an investment company whose object wasto invest its funds in group concerns, income from whichwas earned by way of dividend income and interestincome, and dividend income was exempt from taxunder provisions of section 10(33), expenditure incurredon salary during year under consideration, which in turnhad been incurred for purpose of carrying out objects ofassessee-company, had to be disallowed under section14A.

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� Whether amount disallowed u/s. 14A can beadded to the cost of Shares?

� Interest paid on Amount Borrowed for acquiringControlling Interest whether 14A is applicable?

◦ SRISHTI SECURITIES (P.) LTD. V. JCIT [2005] 148 TAXMAN49 (MUM.) (ITAT)

◦ if funds are borrowed by an investment company formaking investment in shares which may be held asinvestment or as stock-in-trade or for purpose ofcontrolling interest in other companies, interest paid onsuch borrowed funds will be deductible under section36(1)(iii).

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� Surplus / Interest free fund for investment in Shareswhether 14A applicable?◦ Reliance Utilities – (2009) 221 CTR 435 (Bom) in relation toSection 36(1)(iii)

� NO Disallowance if no Tax Free Income.◦ CIT vs. M/s. Delite Enterprises (Bombay High Court)If there is no claim for tax-free income, there cannot be anyIf there is no claim for tax-free income, there cannot be anydisallowance u/s 14A (Walfort Shares and Stock Brokers 326 ITR 1(SC), Godrej & Boyce 328 ITR 81 (Bom) & Winsome Textile 319 ITR204 (P&H) referred)

� Share Application Money◦ Chennai ITAT case of MSA SecuritiesHeld Share application money pending allotment since can't giveany income to investor; same cannot attract section 14A at all.

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� Jayant H. Modi vs. JCIT [2012] 28 taxmann.com252 (Mum.) (ITAT)

Loans and Advances given to assessee holdingmore than 10% of shares in a company havingmain object of carrying business as shares andmain object of carrying business as shares andstock brokers. Held that since the loans andadvances made by the company in the ordinarycourse of business condition stipulated in sub-item (ii) of section 2(22)(e) were duly satisfiedand amount of loan could not be regarded as adeemed dividend in hands of assessee.

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� Where any part of the business of a companyother than company whose gross total consistsmainly of income under other head then businessor a company the principal business of which isthe business of banking or the granting of loansand advances consists in the purchase and saleand advances consists in the purchase and saleof shares of other companies, such companiesshall for the purpose of this section be deemedto carrying on a speculation business to theextent to which the business consists ofpurchase and sale of shares.

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� Favourable

◦ CIT v Amritlal & Co 212 ITR 540 (Bom)◦ PCBL Investments V CIT [2012] 20 taxmann.com 748 (Cal.)◦ DCIT vs. Venkateswar Investment & Finance (P.) Ltd.[2005]

93 ITD 177 (KOL.) (ITAT) (SB).

Adverse View� Adverse View

◦ Ganjam Trading Co. (P.) Ltd.vs.DCIT [2012] 25taxmann.com 181 (Mum.)The assessee was trading and investment company havingits main business as making investment in equities andtrading in shares. Therefore the argument of the assesseethat the principal business of the assessee was grantingloans and advances can not be accepted.

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� Maddi Venkatraman & Co. Pvt Ltd V. CIT 229 ITR 534 (SC)It would be against the public policy to allowdeduction in a statute for payments made incontravention of another statute, howevercommercially expedient their payment may becommercially expedient their payment may be

� CIT V. Catholic Syrian Bank Ltd 265 ITR 177 (Kerala)If the levy is compensatory in nature, it should beallowed as deduction. If however, it is penal innature, same ought to be disallowed.

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� Section 45 JA empowers RBI to determinepolicy and give direction to all or any of theNBFC .

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